Technology Conquers TradingA Brief Overview of HFT

Andrew Baker

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Today’s Agenda

• To understand the basics of HFT trading. Trade flows, risks and controls.

Objective

• Risks and Controls• Trend and Trading Complexities

Key Messages

Q&A

• Definitions• High level overview of the industry and technologies

Focus

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HFT Defined…

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Definition of HFT/Low Latency Trading

Primarily involves the submission of non-marketable resting orders (bids and offers) that provide liquidity to the marketplace at specified prices The primary sources of profits are from earning the spread by buying at the bid and selling at the

offer and capturing any liquidity rebates offered by trading centers to liquidity-supplying orders If the firm is layering the book with multiple bids and offers at different prices and sizes, this strategy can

generate an enormous volume of orders and high cancellation rates of 90% or more

Seeks to capture pricing inefficiencies between related products or markets E.g., may seek to identify discrepancies between the price of an ETF and the underlying basket of stocks

and buy (sell) the ETF and simultaneously sell (buy) the underlying basket to capture the price difference

Exploiting structural vulnerabilities in the market or in certain market participants E.g., by obtaining the fastest delivery of market data, a trader may profit by identifying market participants

who are offering executions at stale prices

Order anticipation strategies: Seeking to ascertain the existence of one or more large buyers (sellers) in the market and buying (selling) ahead of the large orders with the goal of capturing a price movement in the direction of the large trading interest

Momentum ignition strategies: initiating a series of orders and trades in an attempt to ignite a rapid price move either up or down

___________________________Source: SEC Concept Release on Market Structure (http://www.sec.gov/news/press/2010/2010-8.htm); (1) TABB Group. “US Equity High Frequency Trading: Strategies, Sizing and Market Structure, by Larry Tabb, Robert Iati and Adam

Sussman.

As Described in SEC Concept Release on Equity Market StructureAs Described in SEC Concept Release on Equity Market Structure

Passive MarketMaking

Passive MarketMaking

ArbitrageArbitrage

StructuralStructural

DirectionalDirectional

"Strategies that fall under HFT include electronic market making, liquidity detection (block/dark), cross-asset arbitrage, short-term statistical arbitrage and volatility arbitrage. The most prevalent equity HFT strategy is

electronic market making, where firms attempt to profit from intraday imbalances in the supply and demand for liquidity.“(1)

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83% of HFT firms trade stocks; 67% trade futures; 58% trade options; 36% trade US treasuries; and 26% trade FX (potential for more moves into the latter asset classes) – According to TABB Group webinar

According to a recent Aite Group report (“High Frequency Trading in the Futures Markets”) – based solely on the activity of professional high frequency trading firms: High frequency trading currently accounts for 25% of futures trading volume, and it is anticipated that this figure will reach 40% in 2015 (http://www.aitegroup.com/reports/201005031.php)

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36

58

67

83

0 20 40 60 80 100

FX

Bonds

Options

Futures

Stocks

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36

58

67

83

0 20 40 60 80 100

FX

Bonds

Options

Futures

Stocks

Asset Classes Traded by HFT Proprietary Shops (% of Firms)

Source: Tabb Group

HFT Expansion Across Asset Classes

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Human Entered[Human Error]

[Interrupts]

Automated/Model Driven[Machine Error]

[Alerts]

How does it happen?

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Risks and Controls

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The Dow crashes 600 points and immediately recovers "Flash Crash" ($862B in 20 mins). http://www.nanex.net/20100506/FlashCrashAnalysis_Intro.html

High-frequency trading and the $440m mistake (buy high, sell low!). Knight Capital loose $440M and are forced to sell company (lost $10M per minute for 45 mins!)

Goldman Sachs mispriced 400,000 exchange traded options. Trading loss around $100M (All options from H > L were priced at $1).

Stockholm Exchange bought down by an order for "-6" Futures Contracts Everbright mistakenly bought $3.8B of Shanghai Composite (sent index up 6% in 2 mins and lost $32M). Suspended

from proprietary trading by regulators.

The Risks

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Definition of Risk: "A situation involving exposure to danger". Definition of HTF: "A trading discipline certain to create unwanted losses - frequency and severity are the only controllable

measures". Transparent Flow. Flow must be easily observable in an aggregated format - Grep free! Centralised controls, both exchange and non exchange (non fragmented IT infrastructure).

Hiring. All IT hires must have >10 years + undergo rigorous personality profiling and intensive training on TRADING

Proportionate focus on Risk Remediation. Fight hardest near the front line (Flow X Complexity = Effort). Unit Testing and Code Coverage. Fragmented markets must adhere to central switches and standard rules (to avoid Flash Crash). 80-20 Rule - 80% of time spent on defending the outcome - 20% of time achieving the outcome. Manage "code rot". Slight imperceptible changes in the environment cause things to break. Classically these

will get flagged under the "it should never have worked" bucket (http://www.techrepublic.com/blog/software-engineer/how-to-prevent-code-rot/).

The Control Principles

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Message Rates: Average number of message per day 2-5 million (orders, amends and cancels). Fill rates around 1-2%.

DMA Market Share/Rank: Ranked #1 for DMA trading since Dec 2010. Market share varies between 5% and 20% ADV.

Latency Profile (micros)Trades\Messages Per Day

HFT ABCAP (2012)

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Lets Go Shopping!

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The Shopping List

Native Platforms: Nearest thing to sponsored access with single digit microsecond latency. Cons: Exposed to exchange API maintenance.

Field Programmable Gate Array (FPGA): Hardware bound solutions that offer fast/mass parallelism using HDL. Cons: Have to re-programme your applications in HDL.

Infiniband: TCP 20 Microseconds, TCP Bypass 10 Microseconds, InfiniBand 5 Microseconds. Cons: Have to re-programme your applications.

Artisa: Ultra fast routers. Cons: Cost + need wide network to get best value. Solaflar: Wide and fast NIC cards. Cons: Require 10gb networks (no real gain over WAN). Ring (or circular) Buffer: Fast and memory efficient. Cons: Have to re-programme your

applications. Disruptors: An optimisation for ring buffers. Cons: Power consumption (co-lo). CUDA: NVIDA parallel computing architecture (speeds up complex calculations). Cons:

Have to re-programme your applications + quote from the writer of Cell "The quants on Wall Street must have a tolerance for pain that is fairly unique!".

Long line FIX optimisations: Complex, but could yield an enhanced trading experience. Exegy Market Data: High Capacity and Low Latency hardware based market data provider.

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Questions